Institute for Empirical Research in Economics

University of Zurich

Working Paper Series

ISSN 1424-0459

pu#lished in, -ournal of Economic 5iterature, 40, 2002, pp. 402-4=5

Working Paper No. 80

revised version

WHAT CAN ECENEMISTS 5EARN JREM HAPPINESS

RESEARCHL

Bruno S. Frey and Alois Stutzer

October 2001
 WHAT CAN ECONOMISTS LEARN FROM HAPPINESS
RESEARCH?

BRUNO S. FREY and ALOIS STUTZER1

(revised version dated 30 October 2001)

1 Why Study Happiness?

Happiness is generally considered to be an ultimate goal in life; virtually everybody wants to
be happy. The United States Declaration of Independence of 1776 takes it as a self-evident
truth that the “pursuit of happiness” is an “unalienable right”, comparable to life and liberty. It
follows that economics is – or should be – about individual happiness. In particular, the
question is how do economic growth, unemployment and inflation, as well as institutional
factors such as good governance, affect individual well-being?

In addition to this intrinsic interest, there are three major reasons for economists to consider
happiness. The first is economic policy. At the micro-level, it is often impossible to make a
Pareto-optimal proposal, because a social action entails costs for some individuals. Hence an
evaluation of the net effects, in terms of individual utilities, is needed. On an aggregate level,
economic policy must deal with trade-offs, especially those between unemployment and
inflation. Using happiness data for twelve European countries and the period 1975 to 1991, it
has (cautiously) been calculated that a one percentage point increase in the unemployment
rate is marginally compensated for by a 1.7 percentage point decrease in inflation (Rafael Di
Tella, Robert MacCulloch, and Andrew Oswald 2001). This result significantly deviates from
the “misery index” which, for lack of information, has simply been defined as the sum of the
percent unemployment rate and the percent annual inflation rate. Another trade-off that can be

1
University of Zurich, Institute for Empirical Research in Economics, Bluemlisalpstr. 10, CH-8006 Zurich,
Switzerland. Phone +41 1 634 37 30/31, Fax +41 1 634 49 07, e-mail bsfrey@iew.unizh.ch,
astutzer@iew.unizh.ch. We wish to thank a large number of scholars and three referees for their detailed
comments on this and previous versions of the paper.
calculated on the basis of estimated happiness functions is the compensating variation for
being unemployed rather than holding a job. For the European countries just referred to, a
move from the lowest income quartile to the highest income quartile would not be enough to
offset the adverse effect of unemployment, suggesting that unemployed people suffer high
non-pecuniary cost. Happiness research can thus usefully inform economic policy decisions.

A second reason why happiness is of interest to economists is the effect of institutional

conditions, such as the quality of governance and the size of social capital on individual well-
being. Research for 49 countries in the 1980s and 90s suggests that there are substantial well-
being benefits from factors such as improved accountability, effectiveness and stability of
government, the rule of law and the control of corruption. The data show that the effects
flowing directly from the quality of institutions are often much larger than those which flow
through productivity and economic growth (John Helliwell 2001).

A third reason for happiness research is to understand the formation of subjective well-being.
This sheds new light on the basic concepts and assumptions in economic theory, as for
instance whether people can successfully predict their own future utilities (George
Loewenstein, Ted O’Donoghue, and Matthew Rabin 2000) or whether individual self-
assessments of predicted, instant and remembered utility are consistent (Daniel Kahneman,
Peter Wakker, and Rakesh Sarin 1997). Moreover, it may help to solve empirical puzzles that
conventional economic theories find it difficult to explain. A paradox needing explanation is,
for example, that in several countries since World War II real income has drastically risen but
self-reported subjective well-being2 of the population has not increased or has even fallen
slightly. In the United States, for example, between 1946 and 1991, per capita real income
rose by a factor of 2.5 (from approximately 11,000 to 27,000 US $ in 1996 US $), but over
the same period of time happiness, on average, remained constant.3 Moreover, at a given
point-of-time, higher income is positively associated with people’s happiness. Yet, over the
life cycle, happiness stays more or less unchanged. Another paradox to be explained is that,
since ancient times, work has been considered a burden for individuals to bear, but empirical

2
Subjective well-being is the scientific term in psychology for an individual’s evaluation of his or her
experienced positive and negative affect, happiness or satisfaction with life. They are separable constructs and
the precise terminology will be used whenever empirical research is cited. Otherwise the terms happiness, well-
being, and life satisfaction are used interchangeably.
3
This is a “well-established finding” (Richard Easterlin 2001, p. 472, 1974, 1995: David Blanchflower and
Oswald 2000; Ed Diener and Shigehiro Oishi 2000; and Charles Kenny 1999).

2
research on happiness strongly suggests that being unemployed, even when receiving the
same income as when employed, depresses people’s well-being markedly. 4

Many happiness research findings add new knowledge to what have become standard views
in economics, while other results challenge it. One finding is the consistently large influence
of non-financial variables on self-reported satisfaction. This does not mean that economic
factors, such as income, employment or price stability are unimportant, but they suggest that
the recent interest in issues, such as good governance or social capital, are well founded. The
findings also enrich our knowledge on discrimination concerning gender, ethnicity and races,
as well as age.

Section 2 discusses the relationship between happiness and utility. It is argued that reported
subjective well-being is a satisfactory empirical approximation to individual utility. Sections
3 to 5 report how the economic variables of income, unemployment and inflation affect
happiness. Section 6 shows that, in addition to current economic conditions, institutional
factors, in particular the type of democracy and the extent of government decentralization,
also systematically influence how satisfied individuals are with their life. The last section 7
provides a summary and discusses the implications for economic policy and economic theory.

2 Happiness and Utility

2.1 Historical Sketch

For a long time, the study of happiness has been the province of psychology.5 Only recently
has this psychological research been linked to economics. The pathbreaking contribution by
Easterlin (1974) was noted by many economics scholars, but at the time found few followers.
General interest in the measurement and the determinants of subjective reported well-being
has been raised by a symposium (Robert Frank 1997; Yew-Kwang Ng 1997; and Oswald
1997). Since the late 1990s, economists have started to contribute large scale empirical
analyses of the determinants of happiness in different countries and periods.

4
In addition to the literature already cited, see e.g. Blanchflower (1996), Andrew Clark and Oswald (1994), Frey
and Stutzer (1999), and Liliana Winkelmann and Rainer Winkelmann (1998).
5
See, for example, Michael Argyle (1987), Diener, Eunkook Suh, Richard Lucas, and Heidi Smith (1999),
Kahneman, Diener and Norbert Schwarz (1999), Alex Michalos (1991), David Myers (1993), Richard Ryan and
Edward Deci (2001), Fritz Strack, Argyle and Schwarz (1991). There are also contributions by sociologists, in
particular Ruut Veenhoven (for example 1993), and political scientists (Ronald Inglehart 1990, Robert Lane
2000).

3
This paper does not intend to provide a general survey on happiness research (which has
already been done by Kahneman, Diener and Schwarz 1999 and Frey and Stutzer 2002).
Rather, we wish to show which insights may be important, if not necessary, for integrating
into economics.

2.2 Objective and Subjective Utility

Standard economic theory employs an “objectivist” position, based on observable choices

made by individuals. Individual utility only depends on tangible goods and services and
leisure. It is inferred from behavior (or revealed preferences), and is in turn used to explain
the choices made. This “modern” view of utility has been influenced by the positivistic
movement in philosophy. Subjectivist experience (e.g. captured by surveys) is rejected as
being “unscientific”, because it is not objectively observable. Most importantly, cardinality of
utility and interpersonal comparability are not necessary for positive demand theory which,
following Occam’s razor, constitutes a great advantage (Lionel Robbins 1932; John Hicks
1934; Roy Allen 1934). The axiomatic revealed preference approach holds that the choices
made provide all the information required to infer the utility of outcomes. Moreover, the
axiomatic approach is not only applied to derive individual utility, but also to measure social
welfare. To do so, social welfare comparison is based on the consumption behavior of
households (Daniel Slesnick 1998; for a critical analysis Ng 1997, 2001).

The positivistic view still dominates in economics. Amartya Sen (1986, p. 18) observes that
“the popularity of this view in economics may be due to a mixture of an obsessive concern
with observability and a peculiar belief that choice [...] is the only human aspect that can be
observed”. Its dominance is reflected in the contents of microeconomic textbooks. However,
not all contemporary economists subscribe to this view.

Numerous scholars have challenged standard economic theory from different angles. There
are countless examples of non-objectivist theoretical analyses in economics. They incorporate
emotions (e.g. Jon Elster 1998), self-signaling (self-esteem), goal completion, mastery and
meaning (e.g. Loewenstein 1999) or status (e.g. Frank 1985). In order to explain human
behavior, interdependent utility functions are considered rather than interpersonally
independent ones (e.g. Clark and Oswald 1998). This challenges established welfare
propositions (e.g. Michael Boskin and Evtan Sheshinski 1978; Heinz Holländer 2001; and
Richard Layard 1980). In the vast literature on anomalies in decision-making (e.g. Richard
Thaler 1992), it is questioned whether utility can generally be derived from observed choices.
Finally, consequentialism, of which utilitarianism is a special case, is not the only aspect
4
relevant for behavior, but procedural utility should also be considered (Sen 1995, 1997; Marc
Le Menestrel 2001). The exclusive reliance on an objectivist approach by standard economic
theory is thus open to doubt, both theoretically and empirically. In any case, it restricts the
possibility of understanding and influencing human well-being.

The subjective approach to utility offers a fruitful complementary path to study the world.
Firstly, subjective well-being is a much broader concept than decision utility; it includes
experienced utility, as well as procedural utility, and is for many people an ultimate goal. That
is not the case for other things we may want, such as job security, status, power, and
especially money (income). We do not want them for themselves, but rather to give us the
possibility of making ourselves happier. Secondly, the concept of subjective happiness allows
us to capture human well-being directly. This creates a basis for explicitly testing
fundamental assumptions and propositions in economic theory.

2.3 Measuring Utility

A subjective view of utility recognizes that everybody has his or her own ideas about
happiness and the good life and that observed behavior is an incomplete indicator for
individual well-being. Accepting this view, individuals’ happiness can nevertheless be
captured and analyzed: people can be asked how satisfied they are with their life. It is a
sensible tradition in economics to rely on the judgement of the persons directly involved.
Therefore, people are reckoned to be the best judges of the overall quality of their life, and it
is a straightforward strategy to ask them about their well-being. With the help of a single
question or several questions on global self-reports, it is possible to get indications of
individuals’ evaluation of their life satisfaction or happiness. Behind the score indicated by a
person lies a cognitive assessment to what extent their overall quality of life is judged in a
favorable way (Veenhoven 1993). People evaluate their level of subjective well-being with
regard to circumstances and comparisons to other persons, past experience and expectations
of the future. Measures of subjective well-being6 can thus serve as proxies for “utility”.

Individuals’ happiness or life satisfaction can be captured in large surveys. A prominent

example of a single-item question on a three-point scale is in the General Social Surveys
(James Davis, Tom Smith, and Peter Marsden 2001). It asks the question: “Taken all together,

6
Subjective well-being is an attitude consisting of the two basic aspects of cognition and affect. “Affect” is the
label attached to moods and emotions. Affect reflects people’s instant evaluation of the events that occur in their
lives. The cognitive component refers to the rational or intellectual aspects of subjective well-being. It is usually

5
how would you say things are these days - would you say that you are very happy, pretty
happy, or not too happy?” Life satisfaction is assessed on a scale from one (dissatisfied) to ten
(satisfied) in the World Values Survey (Inglehart et al. 2000). People answer the question:
“All things considered, how satisfied are you with your life as a whole these days?”. The
Eurobarometer Surveys, covering all members of the European Union, asks a similar
question: “On the whole, are you very satisfied, fairly satisfied, not very satisfied, or not at all
satisfied with the life you lead?” Among the multiple-item approaches, the most prominent is
the Satisfaction With Life Scale (William Pavot and Diener 1993), composed of five
questions, rated on a scale from one to seven.7

As subjective survey data are based on individuals’ judgements, they are prone to a multitude
of systematic and non-systematic biases. It therefore needs to be checked whether people are
indeed capable and willing to give meaningful answers to questions about their well-being.
Moreover, reported subjective well-being may depend on the order of questions, the wording
of question, scales applied, actual mood and the selection of information processed. The
relevance of these errors, however, depends on the intended usage of the data. Often, the main
use of happiness measure is not to compare levels in an absolute sense but rather to seek to
identify the determinants of happiness. For that purpose, it is neither necessary to assume that
reported subjective well-being is cardinally measurable nor that it is interpersonally
comparable. The subjective data can be treated ordinally in econometric analyses so that
higher reported subjective well-being reflects higher well-being of an individual. Whether
happiness measures meet this condition has been widely assessed in psychological evaluation
studies.8 It has, for example, been shown that different measures of happiness correlate well
with one another (e.g. Meredith Fordyce 1988). Factor analyses of self- and non-self-reports
of well-being have revealed a single unitary construct underlying the measures suggesting
their validity (Ed Sandvik, Diener, and Larry Seidlitz 1993). Reliability studies have found
that reported subjective well-being is moderately stable and sensitive to changing life
circumstances (e.g. Joop Ehrhardt, Willem Saris, and Veenhoven 2000; and Bruce Headey
and Alexander Wearing 1991). Consistency tests reveal that happy people are more often
smiling during social interactions (José-Miguel Fernández-Dols and María-Angeles Ruiz-

assessed with measures of satisfaction. It has been shown that pleasant affect, unpleasant affect and life
satisfaction are separable constructs (Lucas, Diener, and Suh 1996).
7
A survey about various measures of subjective well-being is provided by Frank Andrews and John Robinson
(1991).

6
Belda 1995), are less likely to commit suicide9 (Honkanen Koivumaa et al. 2001) and that
changes in brain electrical activity and heart rate account for substantial variance in reported
negative affect (Richard Davidson, John Marshall, Andrew Tomarken, and Jeffrey Henriques
2000). Thus, Diener (1984) in an early survey concluded that “[the] measures seem to contain
substantial amounts of valid variance” (p. 551).

Provided that reported subjective well-being is a valid and empirically adequate measure for
human well-being, it can be modeled in a microeconometric happiness function Wit = α +
βXit + εit that is estimated by ordered probit or logit. Thereby, true well-being serves as the
latent variable. X = x1, x2, ..., xn are known variables like sociodemographic and
socioeconomic characteristics, as well as institutional constraints on individual i at time t. The
model allows us to analyze each factor that is correlated with reported subjective well-being
separately. This approach has been successfully applied in numerous studies on the correlates
of happiness. Advanced methods have been used recently in order to address nonrandom
measurement errors.

Measurement errors, as well as unobserved characteristics, are captured in the error term ε.
They are the source of potential biases as discussed in the following sections on unobserved
personality traits and correlated measurement errors. However, many mistakes in people’s
answers are random and thus do not bias the estimation results. This holds true for the order
of questions, the wording of questions, actual mood, etc.

Nonsampling errors are, however, not always uncorrelated with the variables of interest. A
measurement error perspective (e.g. Marianne Bertrand and Sendhil Mullainathan 2001,
Martin Ravallion and Michael Lokshin 2001) suggests that the inferences can be clouded by
unobserved personality traits that influence individuals’ sociodemographic and
socioeconomic characteristics, as well as how they respond to subjective well-being
questions. For instance, people doing voluntary work report higher life satisfaction (e.g.
Argyle 1999). But volunteering does not necessarily make people happier. If extraverted
people volunteer more often, and it is taken into consideration that extraverts tend to report
higher satisfaction scores (e.g. Kristina DeNeve and Harris Cooper 1998), then the observed

8
Comprehensive discussions of measurement problems are, for example, provided in Andrews and Robinson
(1991), Michalos (1991), Randy Larsen and Barbara Fredrickson (1999), Schwarz and Strack (1999) and
Veenhoven (1993).
9
Suicide is sometimes considered a more valid measure of happiness because it refers to revealed behavior.
However, suicide only captures the tail-end of the distribution of mental well-being. While this is less of a
problem in studying the determinants of low human well-being, it inhibits meaningful statements about average
well-being and thus welfare comparisons.

7
correlation is biased. However, idiosyncratic effects that are time-invariant can be controlled
for if the same individuals are re-surveyed over time. In a longitudinal or panel analysis, it is
possible to consider a specific baseline well-being for each individual. The statistical
relationship between socioeconomic status and reported subjective well-being is then
identified by people who change their socioeconomic status.10

For some questions, a further reason for biases in microeconometric happiness functions may
be relevant: the correlation of measurement errors with individual characteristics. For
example, young people often report lower life satisfaction scores than old people. On the one
hand, this could mean that young people in fact experience lower well-being. On the other
hand, it is possible that age has an influence on how people react and respond to questions
about their subjective well-being. An observed statistical relationship could then reflect only a
spurious correlation. This kind of bias can hardly be overcome by econometric techniques.11
However, it can be mitigated by carefully developed psychological tests and generation of the
data.

In addition to the statistical preconditions to study the determinants of happiness discussed so

far, further conditions have to be met if welfare comparisons are undertaken on the basis of
reported subjective well-being. These conditions are cardinality and interpersonal
comparability of the individual statements of well-being. Economists are likely to be skeptical
about both claims.12 Evidence has, however, been accumulated that both of them may be less
of a problem on a practical level than on a theoretical level (e.g. Kahneman 1999).13 Happy
people are, for example, rated as happy by friends and family members (e.g. Heidi Lepper
1998 and Sandvik, Diener, and Seidlitz 1993), as well as by spouses (Paul Costa and Robert
McCrae 1988). Ordinal and cardinal treatments of satisfaction scores generate quantitatively
very similar results in microeconometric happiness functions (Frey and Stutzer 2000). This is

10
In addition to an unbiased estimation of partial correlations, the question of causality arises. In the example
mentioned above, it is, for example, concluded that volunteering makes people happy. However, there is
evidence that happier people are more willing to contribute to other people’s well-being (e.g. Myers 1993).
Therefore, the observed partial correlation could also mean that happier people do more voluntary work. The
direction of causality cannot easily be identified even in a panel data analysis. Additional information from
qualitative studies, or in the form of instrumental variables, is necessary.
11
Correlated measurement errors are usually no problem for the inclusion of aggregate variables like inflation or
democratic rights in microeconomic happiness functions.
12
But it should be noted that this skepticism coexists with well established propositions in the literature on
income inequality and poverty, taxation, and risk that accept implicit cardinal utility measurement and
interpersonal comparability.
13
Ng (1996) develops a method that yields happiness measures that are comparable interpersonally,
intertemporally and internationally based on the concept of just perceivable increments.

8
consistent with validation results of the income evaluation approach, which focuses on the
translation of verbal evaluations into numerical figures in a context-free setting (Bernard van
Praag 1991). It is shown that the meaning of a sequence of verbal labels is about the same for
all the people in the sample and that the verbal scale is efficiently used as the underlying
intervals are of about equal length. The existing state of research suggests that, for many
purposes, happiness or reported subjective well-being is a satisfactory empirical
approximation to individual utility. It is thus possible and worthwhile to study economic and
institutional effects on happiness.

3 Effects of Income on Happiness

In the following, three aspects of the relationship between income and happiness are
discussed:

! Are persons with high income at a given point in time happier than those with low income
(section 3.1)?

! Does an increase in income over time raise happiness (section 3.2)?

! Are persons in rich countries happier than those in poor countries (section 3.3)?

3.1 Happiness and Difference in Income between Persons

Persons with higher income have more opportunities to achieve whatever they desire: in
particular, they can buy more material goods and services. Moreover, they have a higher
status in society. Higher income therefore yields higher utility, and conversely the poor are
unhappy. This relationship between income and happiness at a particular point in time and
place (country) has been the subject of a large empirical literature. As a robust and general
result, it has been found that richer people, on average, report higher subjective well-being. 14
The relationship between income and happiness, both in simple regressions and when a large
number of other factors are controlled for in multiple regressions, proves to be statistically
(normally highly) significant. In this sense, “income does buy happiness”.

For the United States, figure 1 shows the strong positive relationship between (equivalent)
real income and happiness in 1972-74 and in 1994-96 (using the General Social Survey data).

14
E.g. Blanchflower and Oswald (2000) and Easterlin (1995, 2001) for the United States, Di Tella, MacCulloch
and Oswald (2001) for the member countries of the European Union, and Frey and Stutzer (2000) for
Switzerland.

9
Average happiness is calculated based on the scores of “not too happy” being equal to 1,
“pretty happy” equal to 2 and “very happy” equal to 3.

[Figure 1 about here]

Table 1 shows the corresponding data in more detail.

[Table 1 about here]

In both periods, the mean happiness rating (the higher it is, the happier people are) rises with
income. In the lowest decile of income, the mean happiness scores are 1.92 (for 1972-74) and
1.94 (for 1994-96), for the fifth decile the score is 2.19, and for the tenth and highest decile it
is 2.36. In the United States, people with higher income are happier.

Data for Europe from the Eurobarometer Survey Series (1975-1991) reveal a similar picture.
For example, 88 percent of those persons located in the upper quartile of the income bracket
rate themselves to be “fairly satisfied” or “very satisfied”, while 66 percent of those in the
lowest income quartile do likewise (see the data presented in Di Tella, MacCulloch, and
Oswald 1999).

However, additional income does not raise happiness ad infinitum and not for sure. As may
be seen in figure 1, the relationship between income and happiness seems to be non-linear;
there is diminishing marginal utility with absolute income. The data in table 1 also indicate
that the same proportional increase in income yields a lower increase in happiness at higher
income levels. Within the bottom five deciles, doubling income increases reported happiness,
on average, by 0.05 score points in 1994-96; but only by 0.03 score points for the top five
deciles. Evidence for diminishing marginal utility is also provided by three successive waves
of the World Values Survey covering the years 1980-82, 1990-91 and 1995-97 and including
between 18 and 30 countries (a total of 87,806 observations). It has been estimated that for a
person moving from the fourth to the fifth decile in the distribution of family income,
subjective well-being rises by 0.11 (on a ten point scale with 1.0 indicating the lowest, and
10.0 the highest level of satisfaction). In contrast, moving from the ninth to the tenth decile
increases subjective well-being by only 0.02 (Helliwell 2001, p. 14).

10
Differences in income only explain a low proportion of the differences in happiness among
persons. In the United States, for example, the simple correlation is 0.20 (Easterlin 2001, p.
468). Sometimes these findings are misleadingly interpreted that income is not relevant for
individual happiness. However, the relevance of income is assessed with regard to the size of
the coefficient in a multivariate analysis. A low correlation coefficient might indicate that
other factors are also important in explaining why some people are happier than others.15 In
particular, other economic (in particular unemployment) and non-economic (in particular
health but also personality) factors exert a strong influence that is beyond the indirect
consequences on income. A relevant personality factor that might intervene is, for instance,
that individuals who prize material goods more highly than other values in life tend to be
substantially less happy (Joseph Sirgy 1997). Similarly, people whose goals are intrinsic, i.e.
those who define their values by themselves, tend to be happier than those with extrinsic
goals, i.e. those oriented towards some external reward, such as financial success or social
approval (Tim Kasser and Ryan 2001).

Correlations do not establish causation. It may well be that it is not necessarily higher income
which makes people happier, but rather that happier people earn higher income, e.g. because
they like to work harder, and are more enterprising. In order to test the direction of causation,
the effect of windfalls determining income have been analyzed. British lottery winners and
people receiving an inheritance reported higher mental well-being in the following year. An
unexpected transfer of £50,000 is estimated to raise subjective well-being by between 0.1 and
0.3 standard deviations (Jonathan Gardner and Oswald 2001; see also Stephen Smith and
Peter Razzell 1975; and Philip Brickman, Dan Coates and Ronnie Janoff-Bulman 1978). This
suggests that causation indeed runs from income to happiness.

There may be many different reasons why higher income does not simply translate into higher
happiness. Without doubt, one of the most important ones is that individuals compare
themselves to other individuals. It is not the absolute level of income that matters most but
rather one’s position relative to other individuals. This idea of relative income is part of the
more general aspiration level theory. Concepts of interdependent preferences due to
comparisons with relevant others (see e.g. Gary Becker 1974; Frank 1985; and Robert Pollak
1976) supplement ideas focussing on preference changes due to comparison with, for
example, one’s past consumption level or expected future income.

15
The low correlation may, of course, simply reflect substantial random disturbances.

11
In economics, Easterlin (1974, 1995, 2001) uses the concept of aspirations as a frame of
reference to explain happiness. He acknowledges that people with higher income are, on
average, happier, but raising everybody’s income does not increase the everybody’s
happiness, because in comparison to others income has not improved. This interpretation of
the data is supported by laboratory findings showing the importance of relative judgements
for happiness (Richard Smith, Diener, and Douglas Wedell 1989 and Amos Tversky and Dale
Griffin 1991).

Many economists in the past have noted that individuals compare themselves to significant
others with respect to income, consumption, status or utility. Thorstein Veblen (1899) coined
the notion of “conspicuous consumption”, serving to impress other persons. The “relative
income hypothesis” has been formulated and econometrically tested by James Duesenberry
(1949), who posits an asymmetric structure of externalities. People look upwards when
making comparisons. Aspirations thus tend to be above the level reached. Wealthier people
impose a negative external effect on poorer people, but not vice versa. As a result, savings
rates depend on the percentile position in the income distribution, and not solely on the
income level, as in a traditional savings function.

A major line of research known as “individual welfare functions”, or the Leyden approach,
has been opened by van Praag and Arie Kapteyn (1973) and associates (for a recent survey,
see van Praag and Paul Frijters 1999). A cardinal relationship between income and welfare is
established by asking individuals to add income ranges to a number of qualitatively
characterized income levels.16 Answering this “income evaluation question”, they should take
into account their own situation with respect to family and job. The up to nine qualitative
descriptions ranging from “excellent” to “very bad” are grouped along an interval scale from
0 and 1. The bounded scale reflects that the individual welfare function only measures relative
welfare as perceived by the individual. Every individual evaluates her income by comparing it
with the worst possible situation and the best possible situation of complete satiation. From
this information, it is possible to estimate for each individual (i) the income that is required to
reach a mean welfare level and (ii) the sensitivity of reported economic welfare to ex ante
income changes.

Individual welfare functions have been estimated for several countries with good results,
particularly for the Netherlands and Belgium (see e.g. van Floor Herwaarden, Kapteyn, and

12
van Praag 1977). A particularly interesting aspect is the connection established between the
parameter of what people consider “sufficient” income and their actual income, which
measures the “preference drift” due to a change in income. A positive correlation suggests
that the ex post evaluation of a higher income is smaller than its ex ante evaluation. So what
rich people consider a “sufficient” income, for example, is higher than what poor people
consider a “sufficient” income. It is found that the preference shift “destroys” about 60-80
percent of the welfare effect of an increase in income, so that somewhat less than a third
remains.17 Individuals anticipate substantial gains in terms of satisfaction from higher income,
but in retrospect are often disappointed about the small size of the effects of the gains.

Fred Hirsch (1976), in his book “Social Limits to Growth”, emphasizes the role of relative
social status by calling attention to “positional goods” which, by definition, cannot be
augmented because they solely rely on not being available to others. This theme was taken up
by Frank (1985, 1999) who argues that the production of positional goods in the form of
luxuries, such as exceedingly expensive watches or yachts, is a waste of productive resources,
as overall happiness is thereby decreased rather than increased.

There is little doubt that people compare themselves to other people and do not use absolute
judgements. But it is crucial to know with what other people such a comparison is being
made. In a study of 5,000 British workers, Clark and Oswald (1996) formed the reference
group comprising persons with the same labor market characteristics. They conclude that the
higher the income of the reference group, the less satisfied people are with their job. Social
comparisons within the family are studied by David Neumark and Andrew Postlewaite (1998)
in order to test the role of relative income for utility. They find that the decision of a woman
to go for paid work depends on whether her sisters and sisters-in-law are employed and how
much they earn at their job.

The effect of the distribution of income on happiness has so far been rarely addressed, mainly
due to the lack of suitable data. A fascinating finding by Alberto Alesina, Di Tella, and
MacCulloch (2001) suggests that there is a large negative and statistically significant effect of
inequality on happiness in Europe, but not in the United States. This may be explained by
Europeans having an inequality aversion, while Americans do not. Alternatively, upward

16
For example, “Please try to indicate what you consider to be an appropriate amount for each of the following
cases. Under my/our conditions, I would call a net household income per [month] of: about .......... very bad [...]
about ......... very good. Please enter an answer on each line [...]” (van Praag 1993).

13
social mobility is perceived to be larger in the United States than in Europe, and therefore
being low in the income distribution is not seen as affecting future income.

Most of the research on the relationship between individual income and happiness has been
undertaken for advanced industrial countries. But it has been shown (Carol Graham and
Stefano Pettinato 2001a,b) that the results essentially carry over to both developing countries
and to countries in transition. All this evidence is consistent with a positive relationship
between individual income and happiness within a society at a given point in time. However,
it emphasizes the relevance of the relative position in the income distribution rather than the
absolute level of income.

3.2 Income and Happiness over Time

Several scholars (e.g. Blanchflower and Oswald 2000; Diener and Oishi 2000; Myers 2000;
Kenny 1999; Lane 1998; and Easterlin 1974, 1995) have identified a striking and curious
relationship: per capita income in western countries like the United States, the United
Kingdom and Belgium, but also in Japan, has risen sharply in recent decades, whereas
average happiness has stayed “virtually constant” or has even declined over the same period.
Graphically, the development of income and happiness diverges like open scissors. Consider
figure 2 for Japan.

[Figure 2 about here]

Between 1958 and 1991, income per capita in Japan rose by a factor of six. This is probably
the most spectacular growth in income since World War II. The rise was reflected in almost
all households having an indoor toilet, a washing machine, telephone and color television, as
well as a car (see Easterlin 2000). The open scissors figure also shows, however, that this
tremendous rise in material well-being was not accompanied by an increase in average
satisfaction with life. In 1958, average life satisfaction rated on a 4-point scale was 2.7. In
1991, after more than 30 years of increasing affluence, average life satisfaction still scores 2.7
points.

17
If interdependent preferences are taken into consideration in addition to habit formation, the preference drift
seems to outbalance 100 percent of the welfare effect of income gains (Huib van de Stadt, Kapteyn, and Sara van
de Geer 1985).

14
The same relationship is revealed for the United States in table 1 above. Between 1972-74
and 1994-96, overall mean equivalent real income in the sample has increased from US $
17,434 to US $ 20,767 (19 percent). But the overall mean happiness rating has even decreased
slightly, from 2.21 to 2.17. Income in all deciles (except the third) has increased, yet mean
happiness ratings have fallen, or stayed constant, in eight of the ten deciles.

What can be inferred from these two cases? One position that can be taken is to disregard the
descriptive evidence (i) because there are other western countries like Denmark, Germany and
Italy that experienced substantial real per capita income growth as well as a (small) increase
in reported satisfaction with life in the 1970s and 80s (Diener and Oishi 2000) and (ii)
because it depends on the observation period whether a small increase or decrease in reported
subjective well-being is measured. Moreover, the relationships presented between income and
happiness over time are not analyzed ceteris paribus. However, for the United States, a
negative time trend is also found when individual characteristics are controlled for
(Blanchflower and Oswald 2000). For 12 European countries between 1975 and 1991 there is
no correlation between real GDP per capita and life satisfaction, provided individual
characteristics as well as the unemployment rate, inflation rate and income distribution are
controlled for (Alesina, Di Tella, and MacCulloch (2001).18

Another position that can be taken is to accept that there is no clear cut trend, positive or
negative, in self-reported subjective well-being over periods of 20 to 30 years in rich
countries. The missing correlation is not due to a changing population. It has been shown for
the United States that average happiness of a cohort also remains constant over the life cycle,
despite considerable growth in income (Easterlin 2001).

The results can be taken as an indication that there is more to subjective well-being than just
income level. One of the most important processes people go through is that of adjusting to
past experiences. Human beings are unable and unwilling to make absolute judgements.
Rather, they are constantly drawing comparisons from the past or from their expectations of
the future. Thus, we notice and react to deviations from aspiration levels.

Additional material goods and services initially provide extra pleasure, but it is usually only
transitory. Higher happiness with material things wears off. Satisfaction depends on change
and disappears with continued consumption. This process, or mechanism, that reduces the

18
A more fundamental objection could question whether it is in principle possible to capture trends on a closed
scale. Valuable complementary evidence could be provided by measures of mental well-being like the General
Health Questionnaire (David Goldberg 1972), where much less framing in terms of categories is to be expected.

15
hedonic effects of a constant or repeated stimulus, is called adaptation. And it is this process
of hedonic adaptation that makes people strive for ever higher aspirations.

Adaptation level theory is well grounded in psychology (in particular Harry Helson 1964;
Brickman and Donald Campbell 1971; Allen Parducci 1995; and, for a modern discussion,
Shane Frederick and Loewenstein 1999), as is the concept of aspiration levels (Francis Irwin
1944). According to aspiration level theory, happiness is determined by the gap between
aspiration and achievement (Michalos 1991 and Inglehart 1990, ch. 7). In economics, the
theories of preference change have concentrated on habit formation (e.g. Alfred Marshall
1890; Duesenberry 1949; Franco Modigliani 1949; Robert Pollack 1970; and more recently
Christopher Carroll and David Weil 1994).

There are three important consequences:

(1) The upward adjustment of aspirations induces human beings to accomplish more and
more. They are never satisfied. Once they have achieved something, they want to achieve
even more. The theory of “rising aspirations” does not hold only for material goods and
services but also for many immaterial achievements. A promotion, for example, makes for
temporary happiness, but at the same time raises the expectation and aspiration for further
promotions.

(2) Wants are insatiable. The more one gets, the more one wants. The marginal utility of
income is thus not defined anymore in this framework, as the utility function changes with
the income level.

(3) Most people think that they felt less happy in the past, but expect to be more happy in the
future (Easterlin 2001). This asymmetry can be explained by changing aspirations, as will
be illustrated below.

The effects of changes in income affecting aspiration levels are illustrated in figure 3 (see
Easterlin 2001).

[Figure 3 about here]

Initially, people have a certain aspiration level Al so that income Y1 produces happiness H1.
Raising income, say from Y1 to Y2, raises happiness from H1 to H2. If it rises further, say to
Y3, happiness is further increased to H3. The points a, b and c trace a curve with decreasing

16
marginal utility of income, as normally assumed in economic theory. This curve holds for a
particular point in time. It suggests that higher income indeed makes people happier.

But, over time, aspiration adjusts to the higher income level. The aspiration level curve Al
shifts downward to Am. Ex post, the rise in income from Y1 to Y2 does not produce any
increase in happiness if the aspiration curve indeed shifts as much downward as assumed in
the graph. If the increase in income jacks up aspirations even higher, say to the aspiration
curve Ah, income Y2 produces even less happiness than the lower income Y1.

Aspiration level theory suggests that increases in income and aspiration levels are closely
connected. The increase in happiness expected on the basis of a given aspiration curve – for
example along the points a, b, and c on aspiration curve Al – does not materialize. Rather, an
increase in income is accompanied by a downward shift in the aspiration curve. In
equilibrium, one may, for example, observe that the sequence of points a, e, and f
materializes. As the curves are drawn, higher income matches higher happiness, but an
increase in income produces a much smaller increase in happiness than with given aspiration
levels.

As indicated above, the figure helps to explain the asymmetry in evaluations of happiness
referring to the past and to the future. A person with income Y3 judges his or her past
happiness on the basis of the current aspiration level Am. As income has risen, say from Y2 to
Y3, the previous income is evaluated to have produced happiness H1 at point d, which is lower
than today’s happiness level H4, as given at point e. Current happiness is thus taken to be
higher than in the past. In actual fact, when the individuals actually received income Y2, they
had a lower aspiration level and therefore that income actually produced happiness H2 in the
past, which in our figure is even higher than today’s happiness H4.

Future income is also evaluated on the basis of the current aspiration level. Let’s take the case
of a person situated at point e with income Y3 and happiness H4. He or she anticipates that an
increase in income from Y3 to Y4 produces a well-being along curve Am, so that happiness H3
at point f is to be expected. But the person does not take into account that the aspiration level
also rises and that the aspiration curve will therefore shift downwards, say to curve Ah. In
actual fact, therefore, when the higher income Y4 is indeed reached, the level of happiness is
only H4 at point h, and not H3 as would have been the case if the aspiration level had stayed
constant at point f. The actual happiness of the increase in income is thus systematically lower
than expected beforehand (in our figure 3, happiness even stays constant).

17
3.3 Income and Happiness between Different Countries

Various studies provide evidence that, on average, persons living in rich countries are happier
than those living in poor countries (for example Diener, Marissa Diener and Carol Diener
1995 and Inglehart 1990). The differences in income between the countries are measured by
using exchange rates, as well as purchasing power parities, in order to control for the
international differences in the cost of living. Data on happiness are usually from the World
Values Survey, the best source available today for international comparisons of life
satisfaction (Inglehart et al. 2000).

Figure 4 illustrates the relationship between income per capita and average life satisfaction in
51 countries for data from the two waves of the World Values Survey in the 1990s.

[Figure 4 about here]

The figure shows that reported subjective well-being seems to rise with income. Some of the
authors identify a concave relationship: income provides happiness at low levels of
development but, once a threshold (around $ 10,000) is reached, the average income level in a
country has little effect on average subjective well-being.

A visual inspection of the relationship between income and happiness across countries is,
however, of limited value. The positive correlation may be produced by factors other than
income alone. In particular, countries with higher per capita incomes tend to have more stable
democracies than poor countries. So it may well be that the seemingly observed positive
association between income and happiness is in reality due to more developed democratic
conditions (see section 6).

In addition to democracy, there may be other conditions correlated with income, which may
produce the observed positive correlation between income and happiness. To mention two
more: the higher the income is, the better the average health and the more secure the basic
human rights. Thus, both health and basic human rights may seemingly make happiness rise
with income.

Moreover, the positive correlation may come as a surprise in the light of evidence presented
for happiness over time, where no robust relationship between income per capita and
happiness is found. There are two possible strategies to further address the role of absolute
income in happiness in and between countries. First, cross-sectional data for several periods

18
can be combined in order to allow a control of time-invariant country specific characteristics.
These characteristics could comprise stable cultural differences, systematic distortions due to
language differences and so on. Such an approach is followed in a study mentioned before
combining data for 49 countries from the first three waves of the World Values Survey.
Instead of country specific effects, separate base levels for six groups of countries are taken
into consideration in the estimation equation: industrial countries, Scandinavia, countries of
the former Soviet Union, other countries of Eastern Europe, Latin American countries, and
other developing countries.19 It is found that national income per capita (measured in
percentage of the value for 1997 in the United States) has a very small effect on reported
subjective well-being. A 10 percent increase in per capita incomes in a country with half the
level of the United States (and unchanged income distribution) raises average satisfaction
with life by only 0.0003 score points on a scale from one to ten, and the gain disappears even
before the US 1997 level of real per capita income is achieved (Helliwell 2001, p. 15).

This evidence is more in line with the findings for income and happiness over time than with
previous results from cross-section studies that neglected country or region specific
determinants of reported subjective well-being. However, it may be argued that poor
countries are not adequately represented in the data pool. As the relationship between income
and happiness seems relevant, especially from a development perspective, a second strategy
could directly address subjective well-being in developing countries. However, extended time
series about reported subjective well-being in developing countries with strong economic
growth are lacking so far. Promising projects are a socio-economic panel in Russia (Ravallion
and Lokshin 2001) and repeated surveys in 17 Latin American countries (Graham and
Pettinato 2001b). First evidence for Peru and Russia indicates that economic development is
accompanied by extensive social mobility and, for some people with fast increasing aspiration
levels, that may depress overall well-being gains from increased economic wealth. While
perceived past mobility and prospects of upward mobility have a positive effect on reported
subjective well-being, there is a fraction of “frustrated achievers” that, in spite of objective
mobility, reports negative perceived mobility and low satisfaction with life (Graham and
Pettinato 2001a).

Another aspect to consider is whether, when income and happiness between countries are
compared, causality runs from income to well-being, as implicitly assumed so far. An inverse
causation can well be imagined (see for example Kenny 1999). It might, for instance, be

19
The strategy of constructing groups of countries is chosen in order to leave more degrees of freedom in the

19
argued that the more satisfied the population is with its life, the more it is inclined to work
hard, and therefore the higher is its per capita income. Or, in other words, happy people may
be more creative and enterprising, leading again to higher income. So far, this line of
argument has not been well understood but should be seriously considered in the future.

The available evidence suggests that across nations income and happiness are correlated but
that the effects are small and diminishing. This indicates that on the one hand other factors
may be more important to explain differences in reported subjective well-being between
countries, and on the other hand that the notion that people in poor countries are happier
because they live under more “natural” and less stressful conditions is a myth.

4 Effects of Unemployment on Happiness

Two questions and their ramifications will be discussed:

! What is the level of happiness of an unemployed person (section 4.1)?

! How does general unemployment in an economy affect happiness (section 4.2)?

4.1 Personal Unemployment

Reports on subjective well-being help to identify the level of utility of unemployed people.
How particular people are affected when they become unemployed has been studied with
individual data for twelve European countries over the period 1975-1991, employing
Eurobarometer data on satisfaction with life on a four point scale (Di Tella, MacCulloch, and
Oswald 2001). The analysis, which controls for a large number of other determinants of
happiness, such as income and education, finds that the self-proclaimed happiness of those
persons being unemployed is much lower than employed persons with otherwise similar
characteristics. The loss of subjective well-being experienced by unemployment amounts to
0.33 units in the satisfaction scale, ranging from 1 (“not at all satisfied”) to 4 (“very
satisfied”).

Many other studies have also found that, for many different countries and time periods,
personally experiencing unemployment makes people very unhappy.20 In their path-breaking
study for Britain, Clark and Oswald (1994, p. 655) summarize their result as “joblessness

statistical analysis.

20
depressed well-being more than any other single characteristic, including important negative
ones such as divorce and separation.” Some analyses offer additional results for particular
groups of unemployed people. While the picture is not totally consistent, many studies find
that unemployment on average weighs more heavily on men than on women. Younger and
older employees suffer less when hit by unemployment than employees in the middle of their
working life. For Germany, it has, for example, been found that unemployment does not
reduce satisfaction with life of women over 50 (Knut Gerlach and Gesine Stephan 1996).
People with high education experience a larger decrease in their subjective well-being due to
unemployment than employees with low education (Clark and Oswald 1994).

All these results refer to the “pure” effect of being unemployed. The income loss, as well as
other indirect effects, which may, but need not, go with personally being unemployed, are
controlled for.

It could be argued that what has been found could be interpreted quite differently. While the
negative correlation between unemployment and happiness is well established, it may well be
that the causation runs in the opposite direction implied so far: unhappy people do not
perform well, and therefore get laid off. Happy persons are fitter for working life, which
makes it less likely that they will lose their job. The question of reverse causation due to a
selection bias has been analyzed in many studies with longitudinal data, before and after
particular workers lose their jobs, for example due to a plant closure. There is evidence that
unhappy people are indeed not performing well on the labor market, but the main causation
seems clearly to run from unemployment to unhappiness (see e.g. Winkelmann and
Winkelmann 1998 for German panel data, or Gary Marks and Nicole Fleming 1999 for
Australian panel data, the latter considering in detail various effects on mental health).21

As the lower subjective well-being of unemployed people can neither be explained by the
lower income level nor the self selection of intrinsically less happy people, unemployment
has to be related to non-pecuniary costs. The drop in happiness may, to a large extent, be
attributed to psychological and social factors (see, e.g., the survey by Norman Feather 1990):

20
E.g., Anders Björklund and Tor Eriksson (1998) for Scandinavian countries, Blanchflower and Oswald (2000)
for the United Kingdom and the United States, Thomas Korpi (1997) for Sweden, Ravallion and Lokshin (2001)
for Russia, and William Darity and Arthur Goldsmith (1996) for a survey.
21
Studies in social psychology also identify effects of unemployment and re-employment on mental well-being.
Studies that explicitly control for individual heterogeneity with a longitudinal design are, e.g., Mary Dew,
Evelyn Bromet and Lili Penkower (1992) and Brian Graetz (1993). For a recent survey, see Gregory Murphy
and James Athanasou (1999).

21
! Psychic Cost. Unemployment produces depression and anxiety, and results in a loss of
self-esteem and personal control. Especially for persons very involved in their work, not
having a job is a heavy blow. It has been established in numerous studies (see Goldsmith,
Jonathan Veum, and Darity 1996) that the unemployed are in worse mental (and physical)
health than people in work. As a result, they are subject to a higher death rate, more often
commit suicide22 and are more prone to consuming large quantities of alcohol. Their
personal relationships are also more strained.

The psychic cost is considerably higher for those being made redundant for the first time.
In contrast, persons who have been unemployed more often in the past suffer less, that is
to some extent they get used to being unemployed. This finding may to some extent
explain persistent unemployment (Clark, Yannis Georgellis and Peter Sanfey 2001).

! Social Cost. Being unemployed has a stigma attached to it, particularly in a world in
which one’s work essentially defines one’s position in life. This aspect will be further
discussed in the following section.

4.2 General Unemployment

People may be unhappy about unemployment even if they are not themselves put out of work.
They may feel bad about the unfortunate fate of those unemployed and they may worry about
the possibility of becoming unemployed themselves in the future. They may also feel
repercussions on the economy and society as a whole. They may dislike the increase in
unemployment contributions and taxes likely to happen in the future, they may fear that crime
and social tension increase, and they may even see the threat of violent protests and uprisings.

The study of 12 European countries over the period 1975-1991 mentioned above (Di Tella,
MacChulloch and Oswald 2001) finds that – keeping all other influences constant – a one
percentage point increase in the general rate of unemployment from 9 percent (the European
mean) to 10 percent reduces stated life satisfaction by 0.028 units on the four-point scale
applied. This effect is of considerable size. This small rise in unemployment is equivalent to
shifting more than 2 percent of the population downwards from one life-satisfaction category
to another, for example from “not very satisfied” to “not at all satisfied”.

22
In a recent study using longitudinal data for the United States for 1972-91, it is found that state unemployment
rates are significantly positively related to the number of suicides. A one percentage point increase in state
unemployment rates predicts an increase of suicides by 1.3 percent (Christopher Ruhm 2000).

22
The overall effect of unemployment on social well-being can be calculated by adding the loss
experienced by those persons being unemployed to the overall effect of unemployment.
Consider again a 1 percentage point increase in unemployment. In the previous section it was
shown that the unemployed experience a fall of 0.33 in their happiness scale. This figure must
be multiplied by the one percent of the population who have been unfortunate enough to
actually become unemployed: 0.33 x 0.01 = 0.0033. Added to the general effect of a one
percentage point unemployment increase of 0.028, it leads to a total decrease of 0.0313 (Di
Tella, MacCulloch, and Oswald 2001).

This calculation must be taken with a grain of salt. It is at best able to gauge the effects of
unemployment on happiness in an approximate way. One reason for having to be cautious is
that there may be various interactions between personal and more general unemployment,
which may in turn affect the evaluation of happiness.

An important interaction refers to reference groups. As is the case for income, individuals
tend to evaluate their own situation relative to other persons. For most persons,
unemployment lowers their happiness less if they are not alone with their particular fate.
When unemployment is seen to hit many persons one knows or hears of, both the psychic and
the social effects are mitigated. Self esteem is better preserved because it becomes obvious
that being out of a job is less one’s own fault and more due to general developments in the
economy. Stigma and social disapproval are less prevalent if unemployment hits many other
persons at the same time.

In order to empirically test the effect of reference groups on reported well-being, happiness
scores have been regressed on three types of explanatory variables:

! personal unemployment,

! unemployment among a reference group, and

! an interaction variable combining personal and reference group unemployment,

Using as a reference group the employment state of one’s partner or, alternatively, the region
an individual lives in, such a happiness function has been estimated for British data over the
period 1991-96, again keeping all other influences constant (Clark 2000). As in virtually all
previous studies, the unemployed are much more dissatisfied than people with a job, and the
general level of unemployment lowers happiness. In contrast, the unemployed indeed suffer
less when the partner and/or a larger proportion of other people living in their region are also

23
out of work. The same result is reached when general unemployment in the economy is taken
as the point of reference (Peter Kelvin and Joanna Jarrett 1985).

Unemployed people’s well-being, moreover, depends on the strength of the social norm to
work. Social interaction of unemployed people with other community members, the reference
group forced upon themselves, has the effect of showing them how they are expected to
behave, and norm-conforming behavior is enforced through social sanctions. In an estimation
across Swiss communities, it has been shown that the stronger the social norm to live off
one’s own income, the lower is unemployed people’s reported satisfaction with life (Stutzer
and Rafael Lalive 2000).

Reference groups are of major importance for showing the extent to which people are
distressed by their own unemployment. However, what group one refers to is not given, but
can to some extent be chosen (e.g. Armin Falk and Markus Knell 2000). People out of work
tend to associate with other people out of work, partly because they have time to do so, or
partly because they retreat from normal community life. It is also known that marriages and
partnerships have a high risk of breaking down when one of the partners is unemployed. In all
these cases, the definition of the reference group adjusts to one’s labor market status.
Causation then does not run unambiguously from the reference group to the evaluation of
unemployment in terms of happiness.

5 Effects of Inflation on Happiness

In combined time series and cross section studies, the development of inflation in several
countries over the course of time can be analyzed. Of most interest is the study of 12
European countries over the period 1975-91 (Di Tella, MacCulloch, and Oswald 2001). The
mean rate of inflation was 7.5 percent per year. Based on an econometric estimate, which
keeps individual socio-economic characteristics, as well as the unemployment rate constant,
an increase in the inflation rate by one percentage point – say from the mean rate of 8 to 9
percent per year - is calculated to reduce average happiness by 0.01 units of satisfaction, i.e.
from an average level in the sample of 3.02 to 3.01. (Average satisfaction is calculated from a
cardinal interpretation of the 4-point scale that attributes “not at all satisfied” a value of 1,
“not very satisfied” a value of 2 etc.) Correspondingly, an increase in the inflation rate by 5
percentage points (which historically is quite a likely event) reduces subjective well-being by
0.05 units. This is a substantial effect. It means that 5 percent of the population are shifted

24
downwards from one life satisfaction category to the next lower one, e.g. from being “very
satisfied” to “fairly satisfied”.

In order to study the trade-off between inflation and unemployment, the results reported on
the effect of unemployment on happiness, and the results concerning inflation just discussed,
can now be combined (Di Tella, MacCulloch, and Oswald 2001). The question is by how
much, on average, must a country reduce its inflation in order to tolerate a rise of one
percentage point in unemployment? Over the relevant range, happiness is assumed to depend
linearly on the two economic factors, and the estimate controls for country fixed-effects, year
effects and country-specific time trends. It is calculated that a one percentage point increase in
the unemployment rate is compensated for by a 1.7 percentage point decrease in the inflation
rate. Thus, if unemployment rises by five percentage points (say from 3 to 8 percent), the
inflation rate must decrease by 8.5 percentage points (say from 10 to 1.5 percent per year) to
keep the population equally satisfied. The so-called “Misery Index”, which simply adds the
unemployment rate to the inflation rate, distorts the picture by attributing too little weight to
the effect of unemployment, relative to inflation, on self-reported happiness.

6 Institutional Effects on Happiness

6.1 Basic Constitutional Rules

People’s happiness is influenced by the kind of political system they live in. It is to be
expected that people living in constitutional democracies are happier because the politicians
are more motivated to rule according to their interests. If they disregard the wishes of the
population, the politicians and parties in a democracy fail to be reelected and lose their power.
Democratic institutions, in particular the right to participate in elections and vote on issues,
thus contribute to citizens’ happiness.

Researchers on happiness have looked at the interaction between democracy and happiness.
The extent to which a constitution is democratic and allows its citizens to take decisions
according to their own preferences can be captured by various indices of freedom.

Figure 5 presents a graphical representation of a comprehensive measure of freedom,

combined with a 4-point measure of happiness, in 38 mainly developed nations at the
beginning of the 1990s (Veenhoven 2000). A visual test reveals that freedom and happiness
are positively related.

25
 [Figure 5 about here]

The comprehensive index of the constitutional set-up used in this figure refers to the
following three areas:

! Political freedom measures the possibility of citizens to engage in the democratic process
or, conversely, the restrictions on political participation. It is composed of two sub-
indices, the first relating to civil rights, such as freedom of speech (with 11 items), and the
second to political rights (9 items).

! Economic freedom measures the opportunity for individuals to engage in the free
exchange of goods, services and labor. It is based on sub-indices (each in turn composed
of a number of items), referring to the security of money, free enterprise, freedom from
excessive taxation and the possibility of undertaking monetary transfers.

! Personal freedom measures how free one is in one’s private life, for example, to practice
one’s religion, to travel or to get married.

To combine the sub-indices, average z-scores are calculated. All three - political, economic
and personal freedom - are strongly and statistically significantly correlated with happiness
(Veenhoven 2000). Controlling for differences in per capita income, the correlation with
economic, but not political and personal, freedom remains statistically significant. Analyses
with sub-samples suggest that economic freedom contributes to happiness particularly in poor
countries with a low level of general education, while political freedom is more strongly
correlated with subjective well-being in rich countries with a high level of education. In both
cases, differences in income per capita are controlled for (Veenhoven 2000).

Such studies are certainly illuminating, but they can only inform us in a limited way about the
influence of various constitutional conditions on subjective well-being. Countries differ from
each other in many ways, and it is not sufficient just to control for unequal per capita incomes
to capture the influence of democracy. Moreover, the cross-section studies only report
correlations and do not deal with causation. Even if we ignore the other problems, it remains
open whether democracy fosters happiness, or whether happiness is a precondition for
democracy. It has been argued, for instance, that high satisfaction with life in a population
increases the legitimacy of the political regime in power and it may thus foster democracy
(Inglehart 1990, 1999). For Latin America and Russia, one study (Graham and Pettinato

26
2001b) indeed identified a mutual dependence of pro-democracy and pro-market attitudes
with well-being: both raise happiness, but happier people are also more likely to have pro-
democratic and pro-market attitudes. With due caution, it may be hypothesized that, for the
respective respondents, there is a virtuous circle in which attitudes favorable to democracy, to
the market, and to life satisfaction, reinforce each other.

In the following, we concentrate on specific institutions of democracy in one particular

country. This removes many problems, which may arise due to the difficulties of
internationally comparing happiness scores and their determinants across countries.

6.2 Referenda

The possibility of citizens to directly participate in politics is an important feature of

democracy. The constitutions of many countries allow popular referenda, but they are
sometimes only used as a device to inform the government when it no longer knows what to
do. Often it is used as a plebiscite in which the voters are asked to support the government’s
policy. In many cases, it is restricted to local and sometimes trivial issues, while the decisions
on important issues are reserved for the professional political actors in parliament and
government. In the United States, there are many popular referenda at the local level as well
as in some states (especially in California), but the constitution does not allow them at the
national level. The only country with an extensive set of direct political participation rights at
all levels of government, and with respect to all issues, is Switzerland. Of the 728 referenda
made all over the world at the national level between 1900 and 1993, 357 (or almost 50
percent) were held in Switzerland (see David Butler and Austin Ranney 1994).

A referendum, in which all the citizens have the possibility to participate, meets the crucial
requirement that it gives decision-making power to people outside of the group of
(professional) politicians. The constitutional setting determines to a large extent what issues
are put on the political agenda, and what issues are prevented from appearing. In
representative democracies, politicians are often very skilled at not letting those problems,
which are to their disadvantage, be discussed in the democratically legitimized institutions.
For example, they usually succeed in not having their privileges (e.g. their income and
pensions) discussed in open parliamentary sessions. In direct democracies, however, in which
the citizens may put any issue to the ballot, the agenda is much less under the control of the
classe politique.

27
The effect of direct democracy on various aspects of society has been carefully analyzed in a
number of econometric studies for the United States:

! Government expenditure and government revenues are lower in institutions with direct
democracy (John Matsusaka 1995);

! Per capita debt is substantially lower with a referendum requiring a qualified majority
(William McEachern 1978);

! Land prices are higher because people find it attractive to live and work in such
communes (Rexford Santerre 1986);

! Public expenditures for education are higher when a referendum is possible (Santerre
1989).

The following insights have been gained on the basis of econometric studies for Switzerland:

! A comparison of Swiss communes with different degrees of institutionalized forms of

participation in political decisions reveals that the outcomes correspond more closely to
the voters' preferences, the more directly democratic they are (Werner Pommerehne
1990);

! The growth of public expenditure is more strongly determined by demand factors (i.e. by
the citizens' willingness to pay) than by supply factors (in particular by the politicians' and
bureaucrats' own interests) (Pommerehne and Friedrich Schneider 1978);

! Public supply is less costly, the more direct the democratic institutions are (Pommerehne
1978);

! Tax morale is higher than in representative democracies (Pommerehne and Hannelore

Weck-Hannemann 1996; Frey 1997);

! Per capita incomes in cantons with more strongly developed direct participation
possibilities of the citizens are significantly higher than in cantons with less developed
forms of direct participation (Lars Feld and Marcel Savioz 1997).

All these results control for a great number of variables unrelated to direct democracy. They
provide strong evidence that the deviations from the citizens' preferences are indeed
significantly lower in a referendum compared to a representative democracy.

The influence of direct democracy on happiness has been analyzed using data on reported
subjective well-being for Switzerland in 1992-1994 (Frey and Stutzer 2000). The major
explanatory variable is the institutionalized right of individual political participation via

28
popular referenda, which varies considerably between the 26 Swiss cantons. The estimates
reveal that the extent of direct democratic participation possibilities exerts a statistically
significant, robust and sizeable effect on happiness over and above the demographic and
economic determinants normally taken into account. When the full variation in the
institutional variable is considered, i.e. when individuals in the canton with the highest
democracy index (Basel Land) are compared to citizens in the canton with the lowest direct
participation rights (Geneva), the former state with an 11 percentage points higher probability
that they are completely satisfied. This effect is larger than living in the top rather than in the
bottom income category.

6.3 Federalism

The decentralization of decision making is an alternative means for better fulfillment of the
voters' preferences: individuals tend to leave dissatisfying jurisdictions while they are
attracted to those caring for the population's preferences at low cost. The possibility to vote
with one's feet (Charles Tiebout 1956; see also James Buchanan 1965; and Albert Hirschman
1970) tends to undermine regional cartels by politicians. The division of competence between
communities and the cantonal government, or the extent of fiscal decentralization, is thus
another constitutional factor systematically influencing happiness. In the study for
Switzerland mentioned above (Frey and Stutzer 2000), the extent of local autonomy is
measured by an index based on survey results. Chief local administrators in 1,856 Swiss
municipalities were asked to report how they perceive their local autonomy on a 10 point
scale.

The estimate reveals a statistically significant positive effect of decentralization on subjective

well-being. For local autonomy, the proportion of persons who indicate being completely
satisfied with life increases by 3.3 percentage points, compared to a situation in which the
communes are one index point less autonomous vis-à-vis their canton.

7 Summary and Implications

7.1 What Economists Can Learn

The insights gained from research on happiness throw new light on important issues analyzed
in economics. Most important, they enlarge the scope of empirical measurement and provide
new tests for theories.

29
Happiness is not identical to the traditional concept of utility in economics. However, it is
closely related. On the one hand, the concept of subjective happiness is a valuable
complementary approach, which, however, covers many more aspects of human well-being
than the standard concept of utility. On the other hand, subjective well-being can be
considered a useful approximation to utility which economists have avoided to measure
explicitly. This allows us to empirically study problems which so far could only be analyzed
on an abstract theoretical level. Moreover, the analysis of data on subjective well-being may
allow for discrimination between competing explanations for empirical findings in behavior
(for an application, see Stutzer and Lalive 2000). The opportunities offered by information on
well-being and affect may not only enrich field research, but also laboratory research in
experimental economics (see e.g. Gary Charness and Brit Grosskopf 2001 and James Konow
and Joseph Earley 1999). These extensions represent a considerable step forward towards a
social science able to provide useful information.

7.2 Implications for Economic Policy

The insights gained about happiness are in many respects useful for economic policy
undertaken by governments. Some examples suffice to illustrate the point:

! The use of measures of happiness allows for a new way of evaluating the effects of
government expenditure. All too often, the effect is measured by the cost incurred by the
state: the more spent, the better. This is obviously not always the case, and in some
instances lower expenditure would be better. The problem has been approached
scientifically by using benefit-cost analysis. The benefits are the recipients’ marginal
willingness to pay, which is best measured in surveys by a Contingent Valuation analysis.
This method can be complemented by simulations using micro-econometric happiness
functions with a large number of determinants that allow for the evaluation of the
widespread effects of extensive expenditure policies.

! Welfare policy is faced with the question of how much economic destitution is responsible
for persons feeling unhappy. To what extent can persons with low income be helped by
financial support? If low income is due to unemployment, the research results suggest that
providing the person with a higher income can only compensate for the pecuniary effect.
In order to improve people’s well-being, the policy should rather be directed towards
providing the person with appropriate employment.

30
! An important part of anti-poverty policy deals with the question of what “poverty” is.
Traditionally, the definition relies on disposable income. Happiness research allows the
problem to be approached more fundamentally by considering reported levels of
subjective well-being. Such complementary measurement also allows equivalence scales
to be established (Erik Plug and van Praag 1995). They indicate the increase in income
necessary to compensate for a larger family, while maintaining the subjective well-being
of the family.

! Tax policy must consider to what extent various income groups are affected. Is it possible
to achieve social goals by redistributing income, or are the negative effects on subjective
well-being prohibitive? Recently, it has been argued that the fight for relative positions is
socially wasteful, and that the high income recipients, as winners of these status races,
should be more heavily taxed (Frank 1999; more generally Layard 1980). This proposal
has been influenced by the findings of happiness research, which suggest that people
derive more satisfaction from their position in comparison to other income recipients than
from the income level as such. If the redistributive tax policy is able to make this race less
attractive, subjective well-being may be positively affected. But, for an overall evaluation,
this proposal must consider many additional aspects, in particular what possibilities the
high income recipients have to evade increased taxes.

Happiness functions have sometimes been looked at as the best existing approximation to a
social welfare function to be maximized (explicitly e.g. Di Tella, MacCulloch, and Oswald
2001, p. 340). The optimal values of the determinants thus derived are – according to this
view – the goals which economic policy should achieve. It seems that, at long last, the so far
empirically empty social welfare maximization of the quantitative theory of economic policy
(Jan Tinbergen 1956 and Henry Theil 1964) is given a new lease of life.

Such an endeavor is still confronted with fundamental problems of social welfare

maximization (Frey 1983, pp. 182-194). While the shortcoming of empirical emptiness has
been overcome (provided one is prepared to accept happiness functions as a reasonable
approximation to a social welfare function), the government still has little or no incentive to
pursue such a policy. Only a „benevolent dictator“ government would do so (Geoffrey
Brennan and Buchanan 1985). Empirical analyses in Public Choice (see for example Dennis
Mueller 1997) suggest that governments are not benevolent and do not simply follow the
wishes of the population, even in well-functioning democracies, not to mention authoritarian
and dictatorial governments. Hence, to maximize the happiness function neglects the crucial

31
incentive aspect. Therefore, the insights from empirical analyses should serve mainly as
information on favorable economic and institutional conditions. If they are considered to be
convincing by political entrepreneurs and citizens, they are taken up and are proposed in the
political process.

7.3 Implications for Economic Theory

Happiness research adds considerable new insights to well-known theoretical propositions.

This has been shown with the example of how income, unemployment and inflation affect
reported individual well-being.

Effects of income. Most economists take it as a matter of course that higher income leads to
higher happiness. A higher income expands individuals’ and countries’ opportunity set, i.e.
more goods and services can be consumed. The few people not interested in more
commodities need not consume them; they are free to costlessly dispose of any unwanted
surplus. It therefore seems obvious that income and happiness go together (provided, of
course, that the two are correctly measured).

But there are also some economists who do not subscribe to the idea that higher income
produces higher happiness. One of them is John Kenneth Galbraith who, in his famous book
on the Affluent Society (1958), pointed out the limited use of higher private income while the
public sector is starving. The first economist to seriously study the data on happiness,
Easterlin (1974), concluded that “money does not buy happiness”. Another author claiming
that the most cherished values cannot be bought on markets is Tibor Scitovsky with his
Joyless Economy, The Psychology of Human Satisfaction (1976). Scitovsky even argues that a
high level of wealth brings continuous comforts and thereby prevents the pleasure that results
from incomplete and intermittent satisfaction of desires. More recently, Frank, in his Luxury
Fever (1999), emphasizes that ever increasing income and consumption do not bring higher
happiness.

The empirical research on happiness has clearly established that at a given point in time, and
within a particular country, persons with higher income are happier. Over time, however,
happiness in western countries and Japan does not systematically increase, despite
considerable growth in real per capita income. This can be attributed to the rise in aspiration
levels going with increases in income. Between countries, and at per capita income levels
much below the United States, higher average income goes with higher average happiness,
but the improvements in reported subjective well-being seem to be rather small.

32
Effects of unemployment. There are two quite different views about unemployment in
economics. According to the “new classical macroeconomics”, unemployment is voluntary.
People choose to go out of employment because they find the burden of work and the wage
paid unattractive compared to being unemployed and getting unemployment benefits. Other
economists take unemployment to be an unfortunate event to be avoided as much as possible.
For them, to become unemployed is considered to be burdensome and, above all, involuntary.
For those affected, becoming unemployed is considered to be a most unfortunate event.
Happiness research suggests that unemployment strongly reduces subjective self-reported
well-being, both personally and for society as a whole. This is more in line with the view that
unemployment is involuntary for the bulk of people affected.

Effects of inflation. The costs of an increase in the general price level – inflation – are
discussed in theoretical economics on the a priori notions based on the distinction between
anticipated and unanticipated inflation. When price increases are anticipated, individuals can
adjust to them with little, if any cost, while they cannot, when they come as a “shock”.
Adjustment is all the more costly, the higher is the variability in aggregate inflation and in
relative prices caused by an increase in inflation. People then must invest a lot of effort to
inform themselves about, and to insulate themselves from, the expected price increases. They
may make many different errors, for instance in underestimating the extent of future inflation,
or how a particular price changes in comparison with other prices.

Depending on a set of (rather restrictive) assumptions, the welfare costs of rising prices can
be captured by computing the appropriate area under the money demand curve, the basic idea
being that economizing on the use of currency imposes costs in terms of well-being. They are
reflected indirectly by the demand for money curve. Based on this method, the cost of a ten
percent yearly inflation has been calculated to be between 0.3 percent and 0.45 percent of
national income (Stanley Fischer 1981; Robert Lucas 1981). This is very little and suggests
that an anti-inflationary policy rarely is worth the cost it entails in terms of additional
unemployment and real income loss.

But many economists would strongly disagree with this conclusion. They point out that stable
prices are a crucial prerequisite for a sound economy in which suppliers and demanders can
act rationally. Most economists take an intermediate position, not least because the picture
emerging from the existing empirical evidence on the costs of inflation is far from clear (see
the survey by John Drifill, Grayham Mizon, and Alistair Ulph 1990). The “common opinion”
of academic economists probably is that rampant inflation is very dangerous for the economy,

33
while a constant, and hence predictable, but low inflation (say 1-5 percent per year) is not
taken to cause any major problems.

The population seems to feel quite differently. An extensive survey in the United States,
Germany and Brazil (Robert Shiller 1997) finds that people are concerned about quite
different issues connected with inflation than are economists. People seem to disregard the
fact that inflation probably also raises their own nominal income. They obviously concentrate
on the possible harm, but not on the possible benefits, of inflation on their standard of living.
In addition, the survey identifies other concerns generally neglected by economists. One is
that inflation allows opportunists to exploit others in an unfair and dishonest way; another is
that inflation undermines the moral basis of society. Many fear that inflation produces
political and economic chaos and a loss in national prestige due to the falling exchange rate.

Happiness research finds that inflation systematically and sizeably lowers reported individual
well-being. In European countries, the effect on happiness of a one percentage point increase
in unemployment is compensated by a 1.7 percentage point decrease in inflation. The relative
size of inflation is thus smaller than in the “Misery Index”, which attaches equal weight to
both percentage changes.

Effects of democracy. Consequences of democratic rules have mainly been analyzed in

economics with regard to their effects on economic growth. Data on subjective well-being
allow us to look at the interaction between democracy and happiness. The extent to which a
constitution is democratic and allows its citizens to make decisions according to their own
preferences can be captured by various measures. It is found that increased possibilities to
directly participate in public decision-making via popular referenda and a decentralized state
significantly contribute to happiness.

7.4 Open Issues

The research on happiness undertaken leaves many questions open. At the same time it opens
up challenging new areas. Further progress is especially needed in four areas:

Effects of happiness on behavior. Economists have mainly studied the effects of behavior on
subjective well-being, as represented by variables such as unemployment, inflation and
income. The reverse effect has so far received scant attention (for a theoretical investigation
see, for example, Benjamin Hermalin and Alice Isen 1999). In the following, we present some
ideas for future research that are particularly relevant from the economic point of view.

The extent of happiness may influence many important economic decisions. Examples are:

34
! Consumption activities. Happy individuals are more likely to save and spend different
proportions of their income, to distribute spending differently over time, and to acquire
different combinations of particular goods and services than do less happy persons (e.g.
Barbara Kahn and Isen 1993).

! Work behavior. Happier individuals may differ significantly in their behavior on the job.
A large literature on job satisfaction (e.g. Peter Warr 1999) analyzes, for example,
whether more satisfied workers are also more productive (Michelle Iaffaldano and Paul
Muchinsky 1985).

! Investment behavior. It can be hypothesized that happier individuals have a different

attitude to taking risks than less happy individuals. They may also prefer different markets
and types of financial investments.

! Political behavior. Happy individuals are likely to vote for different politicians and
parties, and for different alternatives in referenda, than unhappy individuals. It has, for
instance, been found that such a difference exists where attitudes towards the European
Union are concerned (Francis Castles 1998).

Application of happiness analysis on further areas. There are many topics in economic
research for which a complementary analysis of survey data on subjective well-being would
be worthwhile. Possible questions are:

! Discrimination of women. Is there a relationship between discrimination of women on the

labor market and their life satisfaction (see e.g. Clark 1997; and Alfonso Sousa-Poza and
Andrés Sousa-Poza 2000)?

! Quality of life indicators. How are various quality of life indicators like crime,
environmental quality, traffic accidents, commuting, etc. related to subjective well-being
(see e.g. Michalos and Bruno Zumbo 2000)?

! Growth analysis. Are there systematic differences in measures of subjective well-being

for different paths of growth or development (see e.g. Kenny 1999)?

Special emphasis may be put on a broader set of institutions. Studies on the impact of
institutions on happiness have so far mainly been confined to two elements, namely (direct)
democracy and federalism. They certainly count among the most important basic aspects of a
constitution, but there are many other institutions whose impact on subjective well-being is
worth studying. Examples would be the institutions of monetary policy, such as the extent of
independence of the central bank; the importance of corporatism in policy making; or the

35
prevalence of centralized or firm level wage bargaining between trade unions and employer
associations.

Application of More Advanced Methods. Most comparative studies of happiness between

countries employ multiple cross-section regressions. This has been a very useful starting
point, but the next important step is to use panel data. The spread of this technique in
happiness research is still poor (exceptions are, e.g., Ravallion and Lokshin 2001 and
Winkelmann and Winkelmann 1998), mostly because of the lack of necessary data on
happiness. Another advanced method is demographers’ cohort analysis technique for life
cycle studies. Its application in happiness research is only just beginning (in particular in the
work of Easterlin 2001).

Improved Happiness Measurements. There is also room for improvement in the quality of the
happiness data (e.g. Diener, Suh, Lucas and Smith 1999, pp. 277-8) as well as in its
systematic collection. In particular, there is still a lack of data on subjective well-being in
developing and transition countries. Repeated surveys with equal single- or multi-item scales
in these countries would render superfluous the questionable technique of merging responses
to different happiness questions.

Economists should, however, not be too critical, in view of the deficiencies of what they
traditionally measure and use as indicators for individual and aggregate welfare. National
income, whose shortcomings are obvious, is a case in point.

This paper has reached its goal if it has convinced the reader that happiness research is not a
futile or eccentric activity, but is able to provide relevant new insights and can serve as an
inspiration for future research in economics.

36
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 TABLE 1
HAPPINESS AND EQUIVALENCE INCOME IN THE USA
Equivalence Mean Mean Number of
incomea happiness ratingb equivalence income observations
(1996 US $) 1972-74 1994-96 1972-74 1994-96 1972-74 1994-96
Full sample 2.21 2.17 17434 20767 4214 5171

Decile
1 1.92 1.94 2522 2586 421 499
2 2.09 2.03 5777 5867 419 528
3 2.17 2.07 8694 8634 417 497
4 2.22 2.15 11114 11533 416 542
5 2.19 2.19 13517 14763 391 512
6 2.29 2.29 15979 17666 460 500
7 2.24 2.20 18713 21128 393 527
8 2.31 2.20 22343 25745 447 529
9 2.26 2.30 28473 34688 427 472
10 2.36 2.36 46338 61836 423 565
Source: General Social Survey, National Opinion Research Center. Variables 34, 157 and
1028. ‘Don’t know’ and ‘no answer’ responses are omitted.
a
Total household income divided by the square root of the total number of household
members.
b
Based on score of ‘not too happy’ = 1, ‘pretty happy’ = 2 and ‘very happy’ = 3.

45
 2.5

2.3

2.1

1.9
0 10000 20000 30000 40000 50000 60000 70000
Equivalence income in 1996 US $

1972-74 1994-96 Trend 1972-74 Trend 1994-96

Figure 1. Happiness and Equivalence Income in the U.S.

Source: General Social Survey, National Opinion Research Center.

46
 15000 4

Real GDP
per capita
3.5
12000

3
Life satisfaction
9000

2.5

6000

3000
1.5

0 1
1958 1962 1966 1970 1974 1978 1982 1986 1990
Year

Figure 2. Satisfaction with Life and Income per Capita in Japan between 1958 and 1991

Sources: Penn World Tables and World Database of Happiness.

47
Happi- Al
ness
aspiration
c f Am levels
H3
(Al<Am<Ah)
H2 b Ah
e h
H4

a d
H1

H0 g

Y1 Y2 Y3 Y4 Income Y

Figure 3. Happiness, Income and the Role of the Aspiration Level

48
 9

3
0 5000 10000 15000 20000 25000 30000
GNP per capita in PPP 1995 US $

Figure 4. Life Satisfaction and Income Levels Across the World in the 1990s

Sources: World Values Survey 1990-1993/1995-1997 (ICPSR 2790) and World Development
Report 1997.

49
 3.5

2.5

2
-3 -2 -1 0 1 2
Economic, political and personal free

Figure 5. Freedom and Happiness across Nations

Source: Veenhoven (2000), Appendix 1.

50